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US Treasury and the Fed: too close for comfort?

Some economists have reservations about recent moves to rescue the economy.

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To Murray Weidenbaum, President Reagan's top economic adviser in 1981 and '82, the new Fed has had to take "a more activist stance than the old Fed," considering the serious economic threat facing the nation. He finds it "innovative" to see Chairman Bernanke and Treasury Secretary Henry Paulson working so closely together to deal with the crisis.

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At the same time, he worries somewhat about the Fed's historic independence from the president and his administration, a system set up by Congress in 1913 to assure that politicians do not weaken the soundness of the dollar by inordinate influence on the Fed.

To veteran economist Anna Schwartz, however, the Fed's current policy of lowering interest rates and rapidly expanding the nation's liquidity is a mistake.

"I would like to see the Fed tighten monetary policy," she says in a phone interview from her office in New York at the National Bureau of Economic Research.

Ms. Schwartz is famous among economists as coauthor with Milton Friedman of a book blaming the Fed for the Great Depression by allowing the nation's money supply, that is, cash and deposits in banks, to decline drastically. She and Mr. Friedman are what economists call "monetarists" for their assumption that trends in the Fed's supply of money to the economy lead to cyclical ups and downs.

Schwartz criticizes the Fed's leaders for "handing out money so freely … squandering their funds" and not giving evidence that they are concerned with their prime responsibility, price stability.

As for the danger of deflation – steadily falling prices – she dismisses that as "ridiculous" considering the massive injection of new money into the economy in recent months. She's also astonished that Bernanke has been pushing fiscal stimulus, that is, extra federal spending and tax cuts to boost economic activity. Usually Fed chairmen try to stay out of the fiscal business of Congress.

Now there are reports that President-elect Obama will ask for a stimulus package as big as $700 billion over the next two years.

To economist David Levy, the new measures, including those of the Fed, are essential to offset a dramatic reversal in consumer-debt creation (credit cards, car loans, home mortgages, etc.) as consumers fear for their financial safety. In 2004, consumers added $1 trillion to their debts, $2.4 trillion over the next two years, and $880 billion in 2007. This year consumers are probably repaying some debts, says the chairman of the Jerome Levy Forecasting Center in Mt. Kisco, N.Y.

"We are increasing public debt to replace private debt that is vanishing," he says. "A capitalist economy cannot run without debt creation."

Neither Levy nor Mr. Sinai are optimistic about the economy. It could be the worst recession since the 1930s, says Sinai, but not a depression.